HP Inc. (Hewlett-Packard Company) — Q3 FY2012 Form 10-Q
Reporting period: Three and nine months ended July 31, 2012. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. HP is a global provider of PCs, printing, enterprise technology, software, services and financing.
Financial performance
| Metric | Q3 FY2012 | Q3 FY2011 | Nine months FY2012 | Nine months FY2011 |
|---|---|---|---|---|
| Revenue | $29.669 billion | $31.189 billion | $90.398 billion | $95.123 billion |
| Gross profit / margin | $6.849 billion / 23.1% | $7.288 billion / 23.4% | $20.724 billion / 22.9% | $23.009 billion / 24.2% |
| Operating income (loss) | $(8.833) billion | $2.520 billion | $(4.569) billion | $8.882 billion |
| Net income (loss) | $(8.857) billion | $1.926 billion | $(5.796) billion | $6.835 billion |
| Diluted EPS | $(4.49) | $0.93 | $(2.93) | $3.16 |
| Cash from operations | Not separately stated | Not separately stated | $6.512 billion | $10.239 billion |
Q3 revenue declined 4.9% year over year (2.5% on a constant-currency basis); nine-month revenue declined 5.0% (4.5% constant currency). Products revenue fell 6.7% in Q3, while services revenue declined 1.5%. Financing income was broadly stable.
The reported operating loss includes $9.188 billion of impairment charges: $7.961 billion for Services goodwill and $1.227 billion for the Compaq trade name. Restructuring charges were $1.795 billion in Q3 and $1.888 billion year to date. The filing does not provide a single adjusted consolidated earnings measure excluding these items. Before corporate and other unallocated costs, segment operating earnings were $3.093 billion in Q3 versus $3.290 billion a year earlier.
Cash, cash equivalents and current assets were $9.509 billion and $50.237 billion at July 31, 2012. Current liabilities were $44.919 billion. Total borrowings were approximately $29.7 billion, down from $30.6 billion at October 31, 2011; long-term debt on the balance sheet was $24.063 billion. Stockholders’ equity was $32.010 billion, versus $39.004 billion at fiscal year-end.
For the first nine months, investing used $2.843 billion and financing used $2.203 billion; cash increased $1.466 billion to $9.509 billion. Operating cash flow fell about $3.7 billion year over year, mainly due to lower earnings and cash use for operating liabilities. Capital investment in property, plant and equipment was $2.833 billion. HP repurchased $1.495 billion of stock and paid $755 million in dividends.
Material changes and segment trends
- Personal Systems Group: Q3 revenue decreased 10.1% to $8.620 billion; operating margin fell to 4.7% from 5.9%. Soft PC demand and lower notebook and desktop volumes were key factors.
- Services: Q3 revenue fell 3.1% to $8.754 billion; operating margin declined to 11.0% from 13.7%. HP cited contract rate declines, lower resource utilization and costs from delivery delays. The segment recorded the $7.961 billion goodwill impairment.
- Imaging and Printing: Q3 revenue declined 2.7% to $6.017 billion, while operating margin improved to 15.8% from 14.2%. Supplies and consumer demand remained weak; margin benefited from pricing and product-mix improvements.
- Enterprise Servers, Storage and Networking: Q3 revenue fell 3.8% to $5.143 billion and operating margin decreased to 10.9% from 12.9%, reflecting pricing pressure and mix. Itanium-based server demand was affected by an alliance partner’s announced software-support withdrawal.
- Software: Q3 revenue rose 18.4% to $973 million, largely due to Autonomy; operating margin decreased to 18.0% from 19.5% amid mix, acquisition-related deferred revenue write-downs and integration costs.
- HP Financial Services: Q3 revenue increased 0.3% to $935 million and operating margin rose to 10.4% from 9.4%, helped by lower bad-debt expense.
Consolidated gross margin declined 0.3 percentage points in Q3 and 1.3 points year to date. Management cited competitive hardware pricing, lower-margin ESSN mix, pressure in Services, reduced high-margin supplies mix and currency effects.
Outlook, management commentary and risks
- HP announced a multi-year restructuring plan expected to eliminate approximately 29,000 positions through fiscal 2014. It expects about $3.7 billion in total charges as recognition criteria are met; $1.732 billion had been recorded by July 31. Associated cash payments are expected through the first half of fiscal 2015. Management aims to simplify operations, reduce costs and reinvest savings in areas including cloud, security and information management.
- HP expected approximately $3.0 billion of future cash expenditures for all approved restructuring plans. About $833 million of the enhanced early-retirement benefits is expected to be funded from U.S. pension plan assets.
- HP expected $4.3 billion of U.S. Dollar Global Notes to mature over the next four fiscal quarters, to be repaid using operating cash and borrowing resources. It reported approximately $17.4 billion of available borrowing resources, including commercial paper capacity and uncommitted lines.
- Credit ratings had been downgraded by S&P, Fitch and Moody’s; Fitch’s outlook remained negative. HP said downgrades increased borrowing costs, reduced commercial-paper market capacity and could require additional derivative collateral.
- Management described weak demand, particularly in hardware and printing supplies, and ongoing macroeconomic uncertainty. Risks include execution and savings from restructuring, competitive pricing, product transitions, supplier and component availability, currency, service-contract performance, cybersecurity, acquisitions and pension assumptions.
- Notable contingencies include Indian customs-duty orders against HP’s subsidiary totaling approximately $403 million plus potential additional deposits and interest; appeals were pending. U.S. and German authorities were investigating alleged bribery and related conduct involving the Russia GPO transaction. HP also disclosed tax audits, copyright-levy disputes, employment and securities litigation, and environmental matters. HP stated it believed its recorded provisions were adequate, while warning that unfavorable outcomes could affect results or cash flows.
- HP provided no specific consolidated revenue or earnings guidance in the supplied filing text. It cautioned that interim results are not necessarily indicative of full-year results and that restructuring benefits and investment returns may be delayed or fail to materialize.
Important facts for investors to verify
- Whether the preliminary $7.961 billion Services goodwill impairment estimate changes upon completion of the measurement analysis, and the results of the annual goodwill review, particularly for Software and Autonomy-related goodwill.
- Actual restructuring costs, cash payments, employee exits and realized savings against the plan’s estimates and timeline.
- Underlying operating performance and margins apart from the large impairment and restructuring charges, especially Services execution and PC, printing and ESSN demand.
- Operating cash generation, working-capital trends, upcoming debt maturities, borrowing costs and the effect of credit ratings on liquidity and collateral requirements.
- Developments in Indian customs appeals, the Russia GPO investigations, tax disputes and other material legal contingencies.
- Future pension funding needs and whether HP can sustain its dividend and capital returns while executing its restructuring and investment plans.